Question

2. You are a corporate treasurer who will purchase $1m of bonds for the sinking fund in 3 months. You believe rates soon will fall and would like to repurchase the company's sinking fund bonds, which currently are selling below par, in advance of requirements. Unfortunately, you must obtain approval from the board of directors for such a purchase, and this action can take up to 2 months. What action can you take in the futures market to hedge any adverse movements in bond yields and prices until you actually can buy the bonds? Will you belong, or short? Why?

3. The S&P 500 Index is currently at 1,800. You manage a $9m indexed equity portfolio. The S&P 500 futures contract has a multiplier of $250. If you are temporarily bearish on the stock market, how many contracts should you sell to full eliminate your exposure over the next six months? If T-bills pay 2% per six months and the semiannual dividend yield is 1%, what is the parity value of the futures price? Show that if the contract is fairly priced, the total risk-free proceeds on the hedged strategy in the first part of this question provide a return equal to the T-bill rate.

Answer 1

2.

Since a treasure would like to purchase bonds with $1 million now but cannot do this because of some management constraints. So, he can enter into a long position. This means he can purchase treasury bonds future contract worth of similar account. So in case if rates reduces the treasurer needs to buy back the bond at higher rate than earlier.

But the gains from future contract resulting from rising prices and lower yield of bonds would compensate this higher cost of bonds.